This application discloses an invention that is related, generally and in various embodiments, to enhanced financial methods, products, and systems for managing portfolios of fixed income, equity, or other investments.
Alpha refers to the deviation of the return that an active investment manager can generate compared with the passive return of the asset class exposures of the manager's portfolio. Beta refers to the portion of the return of a portfolio that can be attributed to the return of a relevant market benchmark. Beta essentially reflects the sensitivity of a portfolio to a move in the relevant market index. A portfolio may have multiple betas. In other words, a portfolio may have sensitivities to more than one market index. For a given portfolio, each beta exposure may be estimated using the following equation:(RP−RF)=alpha+[beta×(RM−RF)]+a random error termwhere RP is the return of the portfolio during a period of time, RF is a risk free rate (e.g., Treasury bills), and RM is the return of the relevant market index.
For example, the alpha of an equity manager (e.g., stock manager) with a single S&P 500 beta of 1.0 would be the net return after fees of the manager's portfolio above or below the return of the S&P 500. The alpha of a fixed income manager (e.g., bond manager) with a single Lehman Aggregate Index beta of 1.0 would be the net return above or below the return of the Lehman Aggregate Index. For a portfolio with an S&P 500 beta of 0.50, net of any alpha or randomness, the return of the portfolio less the risk free rate would be expected to move by 50% as much as the percentage move of the S&P 500 above the risk free rate.
Portable alpha in the context of this application refers to a combination of an investment in a liquid portfolio, an investment in an alpha-generating portfolio, an investment in a private equity portfolio, and an investment in a benchmark portfolio, the combination of which is designed to generate fixed income, equity, or other beta exposures. This combination of investments is expected to generate higher average returns over time than would be expected from an investment only in a traditional fixed income, equity, or other portfolio having the same beta exposures.
A swap (e.g., total return swap) refers to a bilateral financial contract where an investor agrees to make payments (e.g., periodic payments), usually based on the London Inter-Bank Offered Rate (“LIBOR”) plus some premium, to a counter-party in return for receiving the total economic performance of a specified asset at the end of the swap. The total economic performance generally is the sum of interest, dividends and other income and the change in value (i.e., appreciation or depreciation) of the underlying asset. A swap allows an investor to receive the economic exposure of asset ownership at a cost of only some premium above LIBOR without a substantial capital outlay. Swap counter-party risk (i.e., credit risk) can be limited by diversification with high quality counter-parties and by settling swaps prior to expiration if the accrued receivables from counter-parties become large.
Portfolios of certain types of alternative investments, such as a fund of funds (e.g., a low volatility fund of hedge funds), can generate high alpha with only small amounts of embedded fixed income, equity, and other beta exposures. Other types of alternative investments, such as a fund of private equity funds, can generate high alpha with larger amounts of embedded beta exposures.
After selecting asset classes an institutional investor often will seek traditional fixed income, equity, or other managers to generate excess returns from fixed income, equity, or other allocations. It is quite difficult, however, to find traditional investment managers who will significantly outperform applicable indices like, for example, the S&P 500 (equity) or various Lehman fixed income indices over long periods of time. Many traditional managers typically invest in very efficient markets, tend to have long-only securities, and tend to stay very close to their benchmark (i.e., tend to take limited active exposures). As such, there is limited opportunity to generate alpha.
Accordingly, there exists a need for enhanced financial methods, products, and systems for managing fixed income, equity, or other market portfolios that seek higher returns, and/or lower risk.